Mid-Atlantic Update - In re Woodbridge Group of Companies, LLC

Bankruptcy Court in Delaware Rules Anti-Assignment Clause in Promissory Note Enforceable Over UCC Anti-Assignment Rules – In re Woodbridge Group of Companies, LLC, et al., No. 17-12560 (Bankr. D. Del. June 20, 2018)

            On June 20, 2018, Judge Carey of the Bankruptcy Court in Delaware ruled that an anti-assignment clause in a promissory note was enforceable under Delaware law, and that UCC provisions restricting anti-assignment clauses were not applicable to override such clauses where the assignment was a sale rather than a grant of a security interest.  The court also distinguished between the “right” to assign and “power” to assign, concluding that an anti-assignment clause together with a provision holding an impermissible assignment “null and void” restricts both the right and power to assign.

            Debtor Woodbridge Mortgage Investment Fund ("Woodbridge") had issued three promissory notes each in the principal amount of $25,000 to certain individual creditors.  Each note contained anti-assignment language requiring prior written consent of Woodbridge and stating that “attempted assignment without such consent shall be null and void.”  Woodbridge filed for chapter 11 bankruptcy, and thereafter the individual creditors assigned the notes and related rights to Contrarian Funds LLC (“Contrarian”).  Contrarian proceeded to file a proof of claim asserting a $75,000 secured claim against Woodbridge, which Woodbridge objected to, asserting the assignment to Contrarian was invalid.

            Three issues were before the court:  

  1. whether an anti-assignment clause contained in a promissory note is a valid restriction on assignment rights under Delaware law and public policy;
  2. whether a non-breaching party to a promissory note in payment default is bound by an anti-assignment clause in situations involving the attempted enforcement in bankruptcy; and
  3. whether the UCC’s anti-assignment provisions overrule and nullify an anti-assignment clause in a promissory note.

            On the issue of Delaware law allowing anti-assignment clauses, the court found the anti-assignment clauses in the promissory notes to be consistent with both Delaware law and public policy.  Applying the modern approach of differentiating between the power to assign and the right to assign, the court explained that an anti-assignment clause alone only restricts the right to assign, which can only support a breach of contract claim.  However, if the clause appears in conjunction with a statement that any attempt to assign without consent shall be null and void, then the power to assign is also implicated.  The promissory notes clearly contained both anti-assignment clauses and “null and void” language, and had thus properly limited the power of the original creditors to assign them.  Judge Carey acknowledged the general principle that anti-assignment provisions are to be construed narrowly, but he emphasized the distinction between “narrow construction” and “wholesale obliteration.”

            Nor was the court willing to decline to enforce the anti-assignment clauses following breach by the borrower.  In rejecting the argument advanced by Contrarian that Woodbridge’s prior breach (i.e., the failure to pay interest on the notes) made the anti-assignment provisions unenforceable, Judge Carey noted the well-established principle that a non-breaching party may not “emerge post-breach with more rights than it had pre-breach.”

            Finally, the court analyzed UCC § 9-408 and the related comments to conclude that the UCC did not override the anti-assignment clauses to permit the assignment of the promissory notes.  The court held that UCC § 9-408, which limits the effectiveness of certain terms in a promissory note restricting assignments when such term “would impair the creation, attachment or perfection of a security interest”, was not applicable in this case because Contrarian had not been granted a security interest in the promissory note, but rather had purchased the note outright.

            This case provides a warning to lenders that the UCC cannot be relied on as a complete statutory shield against anti-assignment language in a promissory note.  Additionally, buyers of debt are reminded of the importance of legal due diligence, as particular drafting in a promissory note and/or its related contracts will dictate the extent to which the debt is transferrable.